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From Theory To Practice

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From Theory To Practice

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

As a beginner in trading options, a firm understanding of moneyness is one of the most basic building blocks. Moneyness simply measures the intrinsic value, or worth, of an option. Since the choice of whether or not to “use” the option (formally referred to as “excercising” the option) rests with the long side of the contract, it is most helpful to view the concept of moneyness through the lens of the long side.

There are three basic types of moneyness: out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM). An OTM or ATM option has no value to the long side because the option contract would provide no incremental benefit over trading the stock in the open market. An ITM option does provide value to the long side because the opportunity to buy or sell the stock at the strike price does give the long side a benefit over trading the stock in the open market. We see both of these explained in detail in this segment.

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